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South Korea: Park strife

The ousting of South Korean president Park Guen-hye from office should accelerate corporate governance reforms in the country, says Ed Wiltshire.

South Korea’s first democratically elected president to be removed from office, Park Guen-hye, faces potential prosecution in a cash-for-favours corruption scandal that has also seen Samsung’s heir apparent hauled before the courts on bribery charges. In the short-term, the fallout will likely be painful for Korea Inc, with other large companies facing their own corruption scandals. Further ahead, however, this may end up a positive for investors if South Korean conglomerates finally undertake long-overdue governance reforms.

Park was finally forced from office after the South Korean constitutional court upheld on March 10 her parliamentary impeachment, forcing a presidential election on May 9. The ruling forfeits Park’s presidential executive immunity and South Korean prosecutors have summoned her to appear for questioning on March 21.1

The allegations against Park result from her links with long-time associate Choi Soon-sil. Choi was indicted for abuse of power on November 20 over allegedly using her position to encourage South Korean household names such as Samsung to donate millions of pounds to foundations under her control.

The preliminary court hearing of Samsung Group co-vice chairman Jay Y Lee started on March 9. He has been detained since February 17 on charges that include bribery and embezzlement. Four other Samsung executives were indicted with Lee.

Prosecutors are now expected to intensify investigations of other large family-run conglomerates, or ‘chaebol’, such as SK Group, Hyundai, Lotte and CJ Group, over suspicions of receiving favours from Park in return for giving money or receiving presidential pardons.2

With a snap election in May, a slowing economy and rising geopolitical tensions in with North Korea and China, Ed Wiltshire, Senior Portfolio Manager, Emerging Market and Asia Pacific Equities at Aviva Investors, looks at the market implications.

Given the political backdrop and ongoing developments at Samsung, the market reaction seems remarkably sanguine. Why is that?

EW: There is no indication that events have affected the day-to-day management or the prospects for the company. Most Samsung subsidiaries climbed by around five per cent on March 14 as the chief financial officer of Samsung Electronics confirmed the review into the company structure that commenced in 2016 would proceed regardless of Jay’s availability or not. The one big fear people had was that the key corporate governance proposals requested by activist investor Elliot Management last October, such as introducing non-executive directors and appointing another independent director, would not take place. Samsung has essentially met Elliot half way, which is more than many expected. The CFO also confirmed the company remains committed to increase dividends.

EW: In terms of reputational risk, institutional investors are accustomed to complex corporate structures and governance shortfalls being part of the way South Korea operates. Smartphone batteries bursting on fire is far more of a reputational issue. However, Samsung’s fundamentals remain strong. The company took a hit on the Galaxy 7 and its response was not ideal. But the company ultimately made the right call. Meanwhile, the fallout from the battery fires has not affected the part of its business that manufactures models for other phone companies.

Samsung Electronics reported strong results for 2016 in January and the best quarterly operating profits in over three years in the fourth quarter. There is also a buzz around the pending launch of the company’s Galaxy 8 model. In some ways it highlights how well the company has weathered the battery storm.

Other South Korean companies are facing their own scandals. Does that concern you?

EW: Lotte is being investigated for allegedly being a major beneficiary from the way the government under Park made its duty free allocations. Charges have not been made yet. Similarly, the chairmen of SK Group and CJ Group are suspected of being granted presidential pardons in return for giving money to Choi’s foundations. Corporate governance issues, such as corruption scandals, are always central to our investment process. So we are treading even more carefully in South Korea at the moment than we usually do.

Can you see parallels between South Korea and Brazil in terms of the market’s response to political corruption scandals?

EW: There are parallels in terms of senior politicians and company champions being caught up in scandals and corruption being part and parcel of how both countries have operated. In South Korea, the domestic market does not tend to sell off because of corruption. Investors often invest in South-East Asia, Latin America or other emerging market regions rather than by country. As South-East Asian investors, several factors need to be weighted off against each other. Yes South Korea has corporate governance issues, but it also has many promising companies. It is a balancing act.

Has the country’s economic slowdown damaged sentiment?

EW: There are some concerns, although imports are holding up well. But the question is more about how the economy is performing relative to others. The issues the country faces – such as fears over US protectionism – apply equally to other countries in South-East Asia. I remain relatively upbeat on the outlook.

Improvements in corporate governance will be positive for South Korea. In many ways the whole Park scandal should accelerate corporate reforms and ultimately lead to better dividends being paid. The country will offer international investors good-quality companies like Samsung that are paying higher dividends and better governance – that’s a positive long-term development.

How do you view the post-Park political environment?

EW: The front runner to succeed Park is Moon Jae-in, who served as the opposition leader of the Minjoo Party between February 2015 and January 2016. He looks set to stand for the Democratic Party on the left. A primary election will be held in the next few weeks to select the Democrat’s candidate. On the right it looks far more muddled, with little time to resolve it. There is no obvious person to replace Park as the Saenuri Party (SP) contender. The main contender had been expected to be acting-president Hwang Kyo-ahn, but he has declined to stand.1

Former United Nations Secretary-General Ban Ki-moon had previously been the favourite to run as the right’s contender at the next general election. However, US indictments in January against his brother and nephew on bribery charges3 dented Ban Ki-moon’s pitch as a clean pair of hands and he has withdrawn from the race.

Are promises of reform likely to be key to the outcome?

EW: There are two things all the likely candidates are focused on: reform of the chaebol on the one hand and the relationship with North Korea. On the reform issue, the question is how far and quickly the candidates want to push it. There were reform measures going through parliament in the latter half of 2016 that were knocked off course by the Park affair. As soon as a new president is in place, those pieces of legislation are likely to be progressed.

The scandal has crystallised the public mood for reform and to deal with the corporate and political corruption in South Korea. The Democrat Party looks far more likely done get something done. So in that sense there has been a shift and a positive one for foreign investors considering exposure to the country.

What about North Korea?

EW: That is the big issue facing administrations across South-East Asia, not just South Korea. It has implications for the relationship between China and America, one that has been fractious since President Trump came to power. The Chinese are clearly worried about North Korea and are uncertain what to do; as is everyone else.

South Korea is in some ways caught in the middle, especially since the deployment of the US Terminal High Altitude Area Defence (THAAD) anti-missile system in South Korea in March. Clearly the Chinese are annoyed at this development, and one way they have expressed their displeasure is through sanctions against South Korean companies.

For instance, Chinese travel agents have been cancelling package tours to South Korea that begin after March 15 at the behest of Beijing. China is a vital source of tourism revenues, with 46.8 per cent of tourists to South Korea in 2016 coming from the mainland.4

Chinese authorities also destroyed 700 kilograms of South Korean cosmetics on the grounds they contain bacteria. Similarly, 23 Lotte Mart supermarkets have been closed in China, officially due to concerns over fire regulations. In reality, it may have more to do with Lotte Group agreeing to a land swap that will allow the South Korean military to locate the THAAD system near the North Korean border.

We assume China will persist with this until the South Korean election in May. This is clearly something investors will have to watch closely, although to put that in context, tensions with North Korea are nothing new.

Important Information

Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at March 16, 2017. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

RA17/0377/30062017

Ed Wiltshire

Portfolio Manager, Emerging Market and Asia Pacific Equities

Main responsibilities

Ed is a portfolio manager on a number of our Asia Pacific and Emerging Market equity strategies.

Experience and qualifications

Prior to joining Aviva Investors, Ed worked for State Street Global Advisors as a passive equity fund manager and quant research assistant. Before this, he worked for PanAgora Asset Management as a marketing assistant.
Ed holds an MA (Hons) in Mathematics from Oxford University and an MSc from Essex University. He also holds the UKSIP Investment Management Certificate.